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What does Brexit mean for retail?

09:00, 10 December 2018
· By CMC Markets

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The UK’s decision to leave the EU is likely to have several implications for the retail industry. Many retailers are already facing difficulties including reduced profit, lower footfall in stores and a battle to save costs.

While the long-term economic effects of Brexit are hard to predict, it is this period of uncertainty which is likely to cause concern for retailers, especially when combined with current problems.

What challenges does Brexit pose for the retail sector?

Brexit poses several challenges for the retail sector, given the UK’s close relationship with the rest of the EU. What the UK’s future relationship will be with the EU is still unclear, and this raises questions around factors such as trade, work forces and supply chains.

Trade

The UK relies heavily on trade with the EU. In 2017, 44% of all UK exports were to the EU (£274bn), and 53% of all UK imports were from the EU (£341bn). EU member states (currently including the UK) are part of a customs union, which means no tariffs on goods moving between these countries. A common tariff is also applied to goods entering from outside the EU.

Following the decision to leave the EU, the UK is required to renegotiate trade agreements with EU member states. The issue of the Irish border (the fact that after the UK leaves the EU, this also becomes the border between the UK and the EU) has been contentious.

The latest agreement reached between the EU commission and the UK contains a ‘backstop’ agreement: the country will remain in a customs union with the EU unless a trade deal that can avoid a hard border in Ireland is reached by the end of transition period in December 2020. Many MPs dislike this backstop, arguing the UK could be tied into a customs union on an indefinite basis, and that it could create a border in the Irish Sea.

However, in order for Britain to exit the EU’s single market and the customs union, customs and regulatory checks become almost inevitable. Any Brexit deal has implications for checks and controls on trade between the UK and the EU which currently are not in place. The current agreement suggests that the extent and nature of these will vary depending on how closely Britain aligns its regulations with the EU.

Both sides have agreed to start negotiations for future trade relations between the UK and the EU soon after Britain’s departure from the EU on 29 March 2019. The aim is to have a deal in place at the end of 2020, although what this deal will look like after the transition period is yet to be decided.

Post-transition trade

The deal could be similar to the European Economic Area (EEA), the arrangement that Norway and Switzerland have with the EU. It would allow near full access to the single market, but would also require free movement of people. Or, there is the possibility of a Canada-EU style trade deal for the UK. Many tariffs would be removed, although there would still be hurdles to trading freely with the EU. Finally, Theresa May still needs to get her deal through parliament. In the most extreme scenario, there is the potential that if she fails, we could still end up with a no-deal or ‘hard’ Brexit. If this were the case, the UK would be forced to trade with the EU with World Trade Organisation (WTO) tariffs.

Dependent on the outcome, UK retailers selling to the EU will still have to conform to EU standards and wider trade policies. They may face increased costs as a result of increased tariffs, import and export prices, as well as compliance issues and costs arising from differences in UK and EU policies. There is also the possibility that retailers would be impacted by the loss of UK influence on EU policy and regulation.

Labour

The UK retail sector relies on a large EU migrant workforce. Depending on the outcome of discussions, any restriction on freedom of movement could mean a restricted labour pool. Retailers may find it harder to recruit for jobs across the sector. The cost of labour may increase if retailers begin to employ more UK nationals to fill positions.

Sterling remains more than 10% below its pre-referendum levels in 2016. The weakness of the pound means less favourable exchange rates. This could impact retailers as the cost of goods purchased abroad become more expensive Currency fluctuations may also impact retailers’ performance, and there is a risk that increased costs might be absorbed by consumers. On the other hand, UK retailers can see the benefits of a weaker pound when selling to the rest of the EU.

Economic uncertainty

For many retailers, the economic effects of the Brexit vote are as much psychological as they are real. A slowing economy, or the perception of it, is likely to lead to less consumer spending. Stagnant consumer spending has the potential to greatly impact the retail sector. Economic uncertainty is also likely to influence retailers’ decision-making processes. Retailers are likely to hold off expanding into new markets until post-Brexit.

Supply chain

Retailers may need to reassess their supply chains and contracts. The knock-on effects from trade agreements may lead to delays in the import and export of goods. Supply chains may therefore be disrupted, and contracts might need to be renegotiated.

For example, a food preparation company headquarted in Germany sells products to the UK as well as other countries in the EU. The company has factories in the Netherlands, Germany and the UK, all producing different products. All ingredients are purchased by the head office in Germany, and many are sourced via third-country distributors. Sales are also arranged by the head office.

The company’s current supply chain follows the route of: a head office/stocking point in Germany, supplies distributed to the three separate factories based in the UK, Germany and the Netherlands, and then products sent to both UK and EU customers.

After Brexit, the flow of goods from the head office to the UK factory could be disrupted. Plus, the transportation of products from the UK factory to EU customers, and from the German and Netherlands factory to UK customers, could face customs formalities.

The company can approach Brexit from different angles. They could either continue with the current product flow and try to maximise the supply chain efficiency, or set two separate product flows for the UK and EU.

A struggling sector – is Brexit solely to blame?

While the prospect of Brexit is likely to add additional pressures on the retail industry, many retailers are already facing problems. The rise of online shopping has hit ‘store-based’ business models hard. Online sales now account for almost 20% of retail sales. Many retailers are having to close stores in an attempt to restructure and save costs – in the first half of 2018, there were 4,400 net closures across the UK high street.

Consumers are also becoming increasingly price sensitive. Inflation and wage growth both have an impact on consumers’ ability to spend. When inflation is low and wage growth is high, consumer confidence is likely to rise. If consumers are spending more, this in turn helps retailers. While there are signs that inflation is slowing and wage growth is picking up, it may be some time before retailers feel the benefits of this.

Are there opportunities for the retail sector?

While it remains to be seen how Brexit will impact the retail sector in the long term, it could in fact provide some opportunities for retailers. A weaker pound means UK retailers may be able to sell more goods abroad, as prices have become cheaper and more attractive. Foreign buyers and international customers wanting British goods might take advantage of a weaker pound, creating a spike in demand for products.

There is also the chance to promote locally-sourced and locally-produced goods over those which are imported. This is already becoming an important trend in food and general retailing, and Brexit could provide a good opportunity for retailers to capitalise on it. The Great Britain campaign, for example, showcases the best of what Britain has to offer. It encourages people to visit, do business, invest and study in the UK, and has secured economic returns of £3.9bn for the country.

Plus, earlier this year, Morrisons became the latest supermarket to embrace locally-sourced products, adding 200 local suppliers to its supply chain. The supermarket’s decision followed a YouGov survey for Morrisons, which found that 68% of UK adults prefer to buy British food. It appears there is growing demand for local produce, which consumers believe is fresher, and that by buying it they support local businesses.

Finally, while store closures seem to be becoming a common theme, it may be that we are seeing a change in the high street, rather than its end. There are likely to be fewer shops, but this could be because the role of the store is changing. The unsettling impact of Brexit may encourage retailers to examine their business models and reinvent, as there is a growing consumer demand for retailers who offer events and experiences in their stores, rather than simply a place to buy. Where retailers have invested in and responded to this growing trend, we are seeing success stories.

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Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75% of retail investor accounts lose money when spread betting and/or trading CFDs with this provider. You should consider whether you understand how spread bets and CFDs work and whether you can afford to take the high risk of losing your money.

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